At United Rentals, Shareholders vs. Bondholders

United Rentals's share repurchase plan is the latest example of an exercise that benefits a company’s shareholders but doesn’t bode too well for its bondholders.

Tuesday, the equipment-rental company--recently the subject of a botched acquisition by Cerberus Capital Management--said it plans to spend around $679 million buying back nearly a third of its common stock in a tender offer.

Associated Press

United Rentals said it separately bought back $679 million of preferred stock that was mostly held by private-equity firm Apollo Management, which invested around $400 million in the company in 1999. (Another investor put in $50 million). But not all of Apollo's stake is being exchanged for cash: United Rentals is issuing $425 million in new bonds that pay a hefty interest rate of 14% annually to the private-equity investors. Those bonds come due in 2014 but may be redeemed earlier.

The preferred stock that Apollo owned had an interest rate of 6.25%, but Apollo wasn't getting a cash return on it before--it would have received $700 million if the sale of United Rentals to Cerberus had gone through. The current deal translates into a single-digit annualized return for Apollo on its investment.

United Rental shares surged around 13% on the news, but its bonds dropped in value because the company will be taking on additional debt--increasing its risk of default. The funds for the share repurchase are coming from the company's cash holdings and part of a $1.25 billion credit facility United Rentals obtained last month. While shareholders get to take some cash off the table, United Rentals is "putting more leverage on at a time when the fundamentals of the rental market have softened," notes Clark Orsky, a credit analyst at KDP Investment Advisors.

This is one of several cases recently in which companies have issued debt to make cash payouts to their equity investors. Firms have been taking advantage of improving conditions in the credit markets in recent weeks, though it isn't clear if that will last for long.

To be sure, had Cerberus’s $4 billion buyout of United Rentals taken place, United Rentals would have assumed a significantly larger debt load. But existing bondholders would likely have been better off under that deal because their investments would have been redeemed early and replaced with new debt.